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Tuesday, July 14, 2009

One of the refrains that has been heard accompanying the string of government bailouts over the last ten months has been, "no more Lehmans." This refers to the Lehman Brothers financial firm which declared bankruptcy last fall after the federal goverment did not come to its rescue. An event which some see as a major contributing factor to the weak economic conditions since then. Hence the refrain.

True to their word, we really haven't seen any other Lehmans since then, but we just might.

Traditionally, CIT provided vanilla loans to small and medium-sized business. “But under its current chief executive, Jeffrey M. Peek, a well-liked Wall Street veteran who lost out several years ago in a race to run Merrill Lynch, CIT made an ill-timed expansion into sub-prime mortgage and student lending” (NYT today).

What happens to CIT will help define exactly where we are with regard to “too big to fail.”

At the end of 2008, CIT had total assets around $80bn, which was about 1/10th the size of Goldman (and about 1/25th the size of Citigroup) and puts it just outside the top 20 publicly traded financial services company. Presumably, it just missed the cut for inclusion in the government’s recent “stress tests”.

So in this case, CIT is the quintissential marginal firm. Whether or not it receives a bailout should clearly indicate what the federal goverment thinks about which firms need to be saved given the current economic environment. Maybe.

Johnson, an MIT economist and former IMF official, is often pessimistic about the prospects for effective governmental intervention in, and reform of, the financial sector. On this story, he seems downright cynical as he ends on this note:

So then it all comes down to political donations. At least in terms of what is in the public record, Mr. Peek has not been overly generous, but he did give money to John McCain – and not to any Democrats. If this is in fact the limit of his recent contributions, I think you know the outcome.

Perhaps its the case that CIT doesn't represent the kind of risk that Lehman did. However, a seemingly haphazard approach to bailouts has its own kind of corrosive effect on the economy.

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